Hi there,A few months ago I bought an expensive condo for $1.5m and paid the 30% downpayment (450k) using cash from a margin account with Interactive Brokers. I have $3m in stocks in there so I'm pretty safe borrowing the 450k and got a very competitive (albeit rising) interest rate. Now I'm fine paying the ~$700/mo in interest they charge me, but I also started looking for ways to generate some income in this account to have the interest be taken care of and slowly reduce the balance until I start paying it off more aggressively in 2-3 years (or sooner, or later, depending on market conditions and interest rates, but my current horizon is 2-3 years).

I've never bought stocks on margin but after doing the math I figured I could borrow another $100k to buy stocks paying dividends, and preferred stocks from big financial institutions look quite interesting (good credit ratings, stable dividends, unlikely to be called if I buy them slightly above par value, etc). Now I understand that we are in an environment where interest rates are rising and expected to continue to do so for as long as the economy keeps improving, and this means preferreds will react in the opposite direction, while I will be paying more in margin interest. I guess I could protect myself by placing stop orders to limit my downside risk and/or sell some of my stocks to shrink the balance if needed. My gut feeling is that the rates will continue to go up in small increments like the 25bp bump we saw recently.

Does that sound like a realistic strategy? Any other suggestions to generate some income? I don't have any REITs in my portfolio and haven't done enough research on them yet to see if they are worth it, but since I'm in a higher tax bracket, even a REIT paying 10% would barely beat preferreds like BCS-D paying 7.82% once I factor the taxes in.

It sounds like this strategy would have a Taleb distribution.Someone here did something similar with credit card balance transfers and investing in oil wells, and the leverage destroyed him when the trade went bad.An announcement they're cutting/suspending the dividend would make the stock plummet before the open, and a stop order would only trigger during the panic.

Be careful about picking up nickles in front of steamrollers, sure the odds of it catching you are minimal, but if it does, it will have a significant impact on your quality of life.

defjukie

Senior Member - 3K

posted: Mar. 21, 2017 @ 7:59a

not sure why you would ever take out $450k in margin to pay for a condo when you have $3m sitting in stocks... your whole plan seems unnecessarily risky and likely to end in disaster if one of your many underlying assumptions goes the other way.

stanolshefski

Addicted Member

posted: Mar. 21, 2017 @ 8:20a

defjukie said: not sure why you would ever take out $450k in margin to pay for a condo when you have $3m sitting in stocks... your whole plan seems unnecessarily risky and likely to end in disaster if one of your many underlying assumptions goes the other way. Significant unrealized capital gains -- and OP probably lives in California, which has a high state tax as wekk,

I've done something similar, though on a smaller scale in a few ways. But I borrowed some from IB on margin to pay for unrelated stuff, and also bought a bit more on margin with them. My dollar amounts are smaller, but nontrivial to me. For a little while I did pursue specific companies with good dividend payouts and history, but nothing like the preferreds you mention. Mine were typically yielding 3%-4%, which was still well above the even better margin rates of a few years ago. But these were very stable dividend payments and somewhat stable stock prices. It roughly had me breaking even on the margin cost vs dividend income.

I had also always had my biggest IB margin purchases in a couple of cheap index funds. Dividend payments were much smaller, but overall performance was far better. So I gradually sold out of all the specific stocks. I won't try to beat the market again, a lesson I luckily learned at a low 'lost opportunity' cost.

I have also gotten some in-lieu payments for dividends. My understanding is that this has nothing to do with having a margin balance, just that I've made my shares available for lending. Probably not worth the tax impact in my case - at times it's been a decent chunk of dividends/in-lieu, but the cut of income on the loaned shares seems relatively insignificant.

wp746911

Senior Member - 1K

posted: Mar. 21, 2017 @ 8:59a

ThomasPaine said: Be careful about picking up nickles in front of steamrollers, sure the odds of it catching you are minimal, but if it does, it will have a significant impact on your quality of life. Lol hilarious!

schop

Senior Member

posted: Mar. 21, 2017 @ 9:03a

mr88 said: unlikely to be called if I buy them slightly above par value I don't understand this logic...

dealgain

Thrifty Member

posted: Mar. 21, 2017 @ 9:29a

disaster written all over it. the game will be over before OP even realizes how deep he/she dug himself in.....

RidicuRuss

Wacky Member

posted: Mar. 21, 2017 @ 12:06p

You could short 5yr treasury bonds at 2.00% and take the proceeds and buy 5yr CDs at 2.5%. IB should let you do 10X margin on these. With 3 mil of capital, you could do a lot of damage.

SlimTim said: You could short 5yr treasury bonds at 2.00% and take the proceeds and buy 5yr CDs at 2.5%. IB should let you do 10X margin on these. With 3 mil of capital, you could do a lot of damage.

Wouldn't that be a loser since the margin interest is ~1.5%, unless IB has CDs now and the trade is somehow self-financing? It's my understanding that shorts create cash but you can't actually withdraw it to use somewhere else.

TravelerMSY

Senior Member - 8K

posted: Mar. 21, 2017 @ 12:19p

The OP could just sell $700/month of stock or whatever to create the cash flows he wants. He'd have to pay taxes one way or another on whatever income securities he bought anyway. And the stock he's holding presumably beats the margin rates, so his account equity should be growing over time even if his debit balance remains static.

TravelerMSY

Senior Member - 8K

posted: Mar. 21, 2017 @ 12:22p

One more thing. I'd consider any new trades by their own merit. Would you still be making this investment even if you had no margin balance outstanding?

ntr91

Greedy Member

posted: Mar. 21, 2017 @ 1:47p

ThomasPaine said: Someone here did something similar with credit card balance transfers and investing in oil wells, and the leverage destroyed him when the trade went bad. Link? I need some Schadenfreude today.

JW10

Senior Member - 3K

posted: Mar. 21, 2017 @ 4:30p

I am trying to create some cash flow. Like OP, I selected some stocks paying about ~ 10 percent per year in dividends. Like OP, I failed to account for margin interest reducing true return and adjusted for income tax effect. I have been fortunate that the stock prices on those stocks has been in my expected trading range. I have started to REDUCE my margined positions before today. That said the market drop ~ 1 percent in a single day is a good reminder what can turn the shark in to shark bait quickly. Like me, OP has a bad premise which I have experienced some negatives in other years and again as recently the past two weeks.

As always, do your homework on any investment. I had a few well rated casino and oil related bonds purchased below par which paid well for a few years. ALL of them went into the bankruptcy courts making my bonds worthless. They pulled a Trump Trick. The businesses are still around with lots of assets. My bonds are dross. I failed to understand bankruptcy court do not protect bond holders and do not take all the company assets to pay something to those holding the bonds.

jimbocobb

Senior Member - 2K

posted: Mar. 21, 2017 @ 5:39p

SlimTim said: I've done something similar, though on a smaller scale in a few ways. But I borrowed some from IB on margin to pay for unrelated stuff, and also bought a bit more on margin with them. My dollar amounts are smaller, but nontrivial to me. For a little while I did pursue specific companies with good dividend payouts and history, but nothing like the preferreds you mention. Mine were typically yielding 3%-4%, which was still well above the even better margin rates of a few years ago. But these were very stable dividend payments and somewhat stable stock prices. It roughly had me breaking even on the margin cost vs dividend income.

I had also always had my biggest IB margin purchases in a couple of cheap index funds. Dividend payments were much smaller, but overall performance was far better. So I gradually sold out of all the specific stocks. I won't try to beat the market again, a lesson I luckily learned at a low 'lost opportunity' cost.

I have also gotten some in-lieu payments for dividends. My understanding is that this has nothing to do with having a margin balance, just that I've made my shares available for lending. Probably not worth the tax impact in my case - at times it's been a decent chunk of dividends/in-lieu, but the cut of income on the loaned shares seems relatively insignificant.>> I have also gotten some in-lieu payments for dividends. My understanding is that this has nothing to do with having a margin balance, just that I've made my shares available for lending.

I don't believe that is totally correct....I believe you will only get payment-in-lieu at Interactive Brokers if you actually have a margin balance...at least that has been my experience and seems to be confirmed by this article:

mr88 said: Hi there,A few months ago I bought an expensive condo for $1.5m and paid the 30% downpayment (450k) using cash from a margin account with Interactive Brokers. I have $3m in stocks in there so I'm pretty safe borrowing the 450k and got a very competitive (albeit rising) interest rate. Now I'm fine paying the ~$700/mo in interest they charge me, but I also started looking for ways to generate some income in this account to have the interest be taken care of and slowly reduce the balance until I start paying it off more aggressively in 2-3 years (or sooner, or later, depending on market conditions and interest rates, but my current horizon is 2-3 years).

I've never bought stocks on margin but after doing the math I figured I could borrow another $100k to buy stocks paying dividends, and preferred stocks from big financial institutions look quite interesting (good credit ratings, stable dividends, unlikely to be called if I buy them slightly above par value, etc). Now I understand that we are in an environment where interest rates are rising and expected to continue to do so for as long as the economy keeps improving, and this means preferreds will react in the opposite direction, while I will be paying more in margin interest. I guess I could protect myself by placing stop orders to limit my downside risk and/or sell some of my stocks to shrink the balance if needed. My gut feeling is that the rates will continue to go up in small increments like the 25bp bump we saw recently.

Does that sound like a realistic strategy? Any other suggestions to generate some income? I don't have any REITs in my portfolio and haven't done enough research on them yet to see if they are worth it, but since I'm in a higher tax bracket, even a REIT paying 10% would barely beat preferreds like BCS-D paying 7.82% once I factor the taxes in.

If you have a $450k margin loan at InteractiveBrokers, I can almost guarantee you will get some in-lieu dividend payments this year, especially if you have a lot of dividend-paying stocks in your $3m portfolio.....it may effectively increase the margin rate you are paying for the loan if you have to pay substantially higher taxes than you were expecting on those dividends....that said, IB has awesome margin rates and I have been very happy with them overall.....what you are suggesting can work if you are disciplined and the market doesn't crash, but I would suggest being ultra conservative and trying to keep your overall margin loan at 20% or less of your equity there....and also investing in very high quality things you would like to own for the long-term...don't chase yields that are too high because they probably come with higher risk as well.....you are in a good position but no need to get too risky with margin exposure.....just listen to your question..."buy more stocks on margin to help pay off margin interest"....all sorts of alarms go off just reading that.

xerty

Senior Member - 4K

posted: Mar. 21, 2017 @ 6:31p

mr88 said: I've never bought stocks on margin but after doing the math I figured I could borrow another $100k to buy stocks paying dividends, and preferred stocks from big financial institutions look quite interesting (good credit ratings, stable dividends, unlikely to be called if I buy them slightly above par value, etc). Now I understand that we are in an environment where interest rates are rising and expected to continue to do so for as long as the economy keeps improving, and this means preferreds will react in the opposite direction, while I will be paying more in margin interest. I guess I could protect myself by placing stop orders to limit my downside risk and/or sell some of my stocks to shrink the balance if needed. My gut feeling is that the rates will continue to go up in small increments like the 25bp bump we saw recently.

Does that sound like a realistic strategy? Any other suggestions to generate some income? I don't have any REITs in my portfolio and haven't done enough research on them yet to see if they are worth it, but since I'm in a higher tax bracket, even a REIT paying 10% would barely beat preferreds like BCS-D paying 7.82% once I factor the taxes in.

Bonus questions: Anybody here getting dividends on margin with IB? Ever got in-lieu payments for dividends (which don't get taxed at capital gain rates)? Dividend paying stocks are much riskier than the typical preferred stock or bond. They drop by the amount of the dividend they pay, so it's not really "free money" to help pay your loan. The risks are more stock market risks, less about interest rates and more about people deciding the debt is a problem, the tax cuts aren't going to be as big or as soon as hoped, or whatever else moves the collective animal spirits to cash out. At IB you could just sell some stock (if you don't have big appreciated gains you're trying to avoid).

Preferred stocks, especially higher quality ones, are in many ways closer long term bonds than they are to common stocks. This means you mostly have interest rate risk, some credit risk if the business goes really poorly, but not as much about broad market risk. Preferred stocks or bonds could in a more realistic way "pay for" your margin costs. Of course this is not risk free, or else it would not pay more than your margin loan. If you borrow at a short term floating margin rate and invest in longer term and / or riskier fixed income style investments, you have to hope that rates don't rise too much and credit risks don't show up.

Fundamentally, you need to ask yourself why these risks are underpriced, otherwise you're just taking extra cost of margin to make random bets on stocks or bonds and hope they go up. "Hope" is a good political slogan but it's a very bad investment thesis. If you aren't going to do any fundamental research on what you're buying, you should probably just sell some of your holdings rather than investing on margin. Or if you've got tax reasons you don't want to sell, just use the margin to finance your short term (few years) purchase until you can pay it back. Let the margin interest accumulate - it won't be much at ~1-2% and you've got plenty of equity so having a little more margin won't matter.

Yes, I have some preferred stocks and they do lose their tax benefits from time to time because I have them in my margin account (and it makes a big difference too). If you held them in a cash account, this wouldn't happen.

mr88

New Member

posted: Mar. 21, 2017 @ 7:53p

homasPaine said: It sounds like this strategy would have a https://en.wikipedia.org/wiki/Taleb_distribution. Someone here did something similar with credit card balance transfers and investing in oil wells, and the leverage destroyed him when the trade went bad.An announcement they're cutting/suspending the dividend would make the stock plummet before the open, and a stop order would only trigger during the panic.

Ah, never heard about the Taleb distribution, thanks for the link. Yes, I've read plenty of horror stories of people going bust with leverage. It's a dangerous game. With ~$3m in equity, after withdrawing $450k in cash from SMA (I haven't upgraded to portfolio margin for other reasons) I'm left with $2.55m in equity. The market value of my account would need to tank 80% before I get a margin call: after tanking 80% it would be worth $600k, so maintenance margin of 25% means I need at least $150k in equity, and 600k - 450k = 150k so I would be good, but beyond that IB would start to liquidate me (at the worst time, of course).

Preferred shares can't cut the dividend, but they can suspend it. Cumulative preferreds eventually pay out the dividends (unless the company goes bankrupt in the mean time).defjukie said: not sure why you would ever take out $450k in margin to pay for a condo when you have $3m sitting in stocks... your whole plan seems unnecessarily risky and likely to end in disaster if one of your many underlying assumptions goes the other way.

Various reasons: current tax situation, future tax situation that will ease a bit in 2018/2019, I'm long on these stocks and would like to not touch them for the time being, etc.

schop said: mr88 said: unlikely to be called if I buy them slightly above par value I don't understand this logic...

The preferreds I'm looking at are issued by ​big banks that issue them to inflate the equity section of their balance sheet. The way I understand it, buying above par means I'm at risk of a capital loss if the issuer calls the stock, but the banks have less of an incentive to call it. Definitely not planning on buying way above par though.TravelerMSY said: One more thing. I'd consider any new trades by their own merit. Would you still be making this investment even if you had no margin balance outstanding?

​Yes, I would still consider making this investment anyways. I honestly wasn't really aware of preferred stocks until 2 weeks ago. Been reading a lot about them since then. I think I understand how they work now.JW10 said: I am trying to create some cash flow. Like OP, I selected some stocks paying about ~ 10 percent per year in dividends. Like OP, I failed to account for margin interest reducing true return and adjusted for income tax effect. I have been fortunate that the stock prices on those stocks has been in my expected trading range. I have started to REDUCE my margined positions before today. That said the market drop ~ 1 percent in a single day is a good reminder what can turn the shark in to shark bait quickly. Like me, OP has a bad premise which I have experienced some negatives in other years and again as recently the past two weeks.

As always, do your homework on any investment. I had a few well rated casino and oil related bonds purchased below par which paid well for a few years. ALL of them went into the bankruptcy courts making my bonds worthless. They pulled a Trump Trick. The businesses are still around with lots of assets. My bonds are dross. I failed to understand bankruptcy court do not protect bond holders and do not take all the company assets to pay something to those holding the bonds.

Yeah the 10% yield ones are definitely way riskier. I am, however, adjusting for margin interest and tax consequences. I'm looking at preferreds from banks like Barclays, HSBC, Deutsche Bank, Citi, ... not quite as likely as casino and oil companies to go bankrupt.jimbocobb said: I don't believe that is totally correct....I believe you will only get payment-in-lieu at Interactive Brokers if you actually have a margin balance...at least that has been my experience and seems to be confirmed by this article:

Very interesting link, thanks. This changes the equation quite a bit for me. If I'm not gonna get the preferential tax rate, I should probably do my homework on REITs before going into preferreds.xerty said: Dividend paying stocks are much riskier than the typical preferred stock or bond. They drop by the amount of the dividend they pay, so it's not really "free money" to help pay your loan. The risks are more stock market risks, less about interest rates and more about people deciding the debt is a problem, the tax cuts aren't going to be as big or as soon as hoped, or whatever else moves the collective animal spirits to cash out. At IB you could just sell some stock (if you don't have big appreciated gains you're trying to avoid).

Preferred stocks, especially higher quality ones, are in many ways closer long term bonds than they are to common stocks. This means you mostly have interest rate risk, some credit risk if the business goes really poorly, but not as much about broad market risk. Preferred stocks or bonds could in a more realistic way "pay for" your margin costs. Of course this is not risk free, or else it would not pay more than your margin loan. If you borrow at a short term floating margin rate and invest in longer term and / or riskier fixed income style investments, you have to hope that rates don't rise too much and credit risks don't show up.

Fundamentally, you need to ask yourself why these risks are underpriced, otherwise you're just taking extra cost of margin to make random bets on stocks or bonds and hope they go up. "Hope" is a good political slogan but it's a very bad investment thesis. If you aren't going to do any fundamental research on what you're buying, you should probably just sell some of your holdings rather than investing on margin. Or if you've got tax reasons you don't want to sell, just use the margin to finance your short term (few years) purchase until you can pay it back. Let the margin interest accumulate - it won't be much at ~1-2% and you've got plenty of equity so having a little more margin won't matter.

Yes, I have some preferred stocks and they do lose their tax benefits from time to time because I have them in my margin account (and it makes a big difference too). If you held them in a cash account, this wouldn't happen.

Hi xerty, I was eagerly awaiting your reply, as I've read your replies in pretty much all the prior posts about margin on this forum

Right, dividend stocks are riskier, that's one thing that's attracting me to the preferred stocks. There is no "free money" anyway. I'm taking on some additional risk for some additional potential returns.Yes, I could very well just sell a bunch of shares every month in order to pay off the interest and slowly shrink my balance. That's what I've been doing until now. I just thought it was interesting to use a bit more margin to go on auto-pilot and preserve my shares and reduce my taxes (but that was assuming I'd get most dividends as qualified dividends, not PIL).

I don't have any dividend paying stocks in my IB account at this point. Didn't transfer those over (and probably will not given what was said about PIL).

As far as credit risk, most of the preferreds I looked into are well rated, from big name financials. There is no zero risk, but that's no unrated security from a small cap player.

One of our own... Although he was outed before, I'll be respectful and not give his handle here.In 2005, two foreclosures pushed Cunningham near financial ruin. Like many Americans, he fell enchanted by the siren's song of easy credit and borrowed more than $100,000 to bet on risky, high-yielding investments, such as stock in the now vilified sub-prime mortgage industry. Then, while stationed with the Army in El Paso, he attempted to become an absentee landlord and got zero-percent-down sub-prime mortgages to buy low-income four-plexes in Houston and Dallas. With the interest earned on his high-yielding stocks he was paying back his low-interest credit card debt; now, he was using the mortgages to borrow even more.Then, the bottom fell out. Investors like Cunningham fell the fastest. He sold his Houston homes, but his Dallas properties were foreclosed on. The collection calls started. He was running scared.As for OPThe preferreds I'm looking at are issued by ​big banks that issue them to inflate the equity section of their balance sheet. The way I understand it, buying above par means I'm at risk of a capital loss if the issuer calls the stock, but the banks have less of an incentive to call it.

ThomasPaine said: As for OPThe preferreds I'm looking at are issued by ​big banks that issue them to inflate the equity section of their balance sheet. The way I understand it, buying above par means I'm at risk of a capital loss if the issuer calls the stock, but the banks have less of an incentive to call it.

I will not be "wiped out". I'd only be borrowing 3% of the value of my assets to try to generate some income so I don't have to deal with margin interest or let my balance grow. I do agree the current bull market had a good run, and I don't have a crystal ball to know when the next correction is due, but one thing I know is that if the preferreds go to shit like they did in '07-'09 as mentioned above, I can easily do nothing and just wait until the market recovers.

My thinking with stop orders was that if I buy preferreds below par that appreciate a bit after a few months, I could put in a stop order to sell them at approximately the face value I bought them for, to get out automatically in case there is a sudden increase in interest rates. But I don't have to do this, it's just something I've been considering. Right now I'm more leaning towards just holding on to them as long as they are from big financials with good credit ratings. Many of these are non-cumulative, so there is also always a risk that they stop paying dividends for an extended period of time as they did just a few years ago. That would be unfortunate, but no big deal. I can wait.

mr88

New Member

posted: Mar. 22, 2017 @ 1:27a

That was an interesting article, BTW, thanks for sharing. I've also been looking into preferreds that have passed their call date and switched to a floating rate, like BML-H (min 3% or 3 month LIBOR + 0.65%). The spread there is too small though. Haven't found any really compelling ones yet.

mr88

New Member

posted: Mar. 22, 2017 @ 1:49a

About the PILs at IB, what I understand is that if IB loaned out some of my shares to somebody (e.g. because they're shorting the stock), then I may get PIL. Since none of the assets I transferred to IB pay dividends, I guess the question is: are there people who short preferreds? That wouldn't make much sense to me, you'd usually be better off shorting the underlying common stock instead.

mr88 said: Hi xerty, I was eagerly awaiting your reply, as I've read your replies in pretty much all the prior posts about margin on this forum . Happy to help and hopefully you'll have a good starting point for thinking about the risks and potential returns. I cut up a bunch of your comments to various people and replied below, sorry if things are a bit jumbled in places.Right, dividend stocks are riskier, that's one thing that's attracting me to the preferred stocks. There is no "free money" anyway. I'm taking on some additional risk for some additional potential returns.

Yes, I could very well just sell a bunch of shares every month in order to pay off the interest and slowly shrink my balance. That's what I've been doing until now. I just thought it was interesting to use a bit more margin to go on auto-pilot and preserve my shares and reduce my taxes (but that was assuming I'd get most dividends as qualified dividends, not PIL). I don't have any dividend paying stocks in my IB account at this point. Didn't transfer those over (and probably will not given what was said about PIL).

I will not be "wiped out". I'd only be borrowing 3% of the value of my assets to try to generate some income so I don't have to deal with margin interest or let my balance grow. I do agree the current bull market had a good run, and I don't have a crystal ball to know when the next correction is due, but one thing I know is that if the preferreds go to shit like they did in '07-'09 as mentioned above, I can easily do nothing and just wait until the market recovers.Yes, you're not taking on very much risk so you won't get wiped out unless the whole stock market blows up something liked 1929; a 50% drop isn't going to do it. You might consider getting a portfolio margin upgrade - it lowers your margin requirements so a margin call is less likely, but again it won't happen so don't bother if you don't want.I honestly wasn't really aware of preferred stocks until 2 weeks ago. Been reading a lot about them since then. I think I understand how they work now.I have been watching and studying preferrred stocks for several years now. I am starting to really understand how they work, how to value them, how to trade them, etc - not an expert on most, but good enough sometimes. I admit I still haven't studied most issues in enough detail to really understand their whole situation and risk profile. I would humbly suggest that your understanding after two weeks is probably still pretty superficial.The preferreds I'm looking at are issued by ​big banks that issue them to inflate the equity section of their balance sheet. The way I understand it, buying above par means I'm at risk of a capital loss if the issuer calls the stock, but the banks have less of an incentive to call it. Definitely not planning on buying way above par though.

Yeah the 10% yield ones are definitely way riskier. I am, however, adjusting for margin interest and tax consequences. I'm looking at preferreds from banks like Barclays, HSBC, Deutsche Bank, Citi, ... not quite as likely as casino and oil companies to go bankrupt.

As far as credit risk, most of the preferreds I looked into are well rated, from big name financials. There is no zero risk, but that's no unrated security from a small cap player.

Right now I'm more leaning towards just holding on to them as long as they are from big financials with good credit ratings. Many of these are non-cumulative, so there is also always a risk that they stop paying dividends for an extended period of time as they did just a few years ago. That would be unfortunate, but no big deal. I can wait.I see you're aware of the noncumulative risk for bank preferreds - that's good (otherwise they don't count favorably for regulatory capital ratios). This means there's a risk that they defer payments if they run into trouble and you never get the missed ones even if they company eventually survives and recovers (and the preferreds will sell off a lot too when this happens). Now if you want your investment back, you have to wait and hope they survive, otherwise you may well get nothing or settle for only a fraction of your par back in the short term.

Also, while big name banks seem safe and may well be "too big to fail", that doesn't mean that the common or preferred shareholders would be bailed out in a collapse scenario. Most likely the depositors would be, or at least some combination of the smaller ones and the politically well-connected ones (ala Cyprus, and everyone else gets stiffed and maybe some shares in the new bank worth a lot less than their lost deposit), but banks like Citi and Deutsche have probably been insolvent at various points in time in the past decade. They just pretended otherwise and as long as everyone played along it works, but a crisis of confidence can happen fast and then those guys would be toast. There are real risks when your institution is 10x leveraged, as most banks are.

Very interesting link, thanks. This changes the equation quite a bit for me. If I'm not gonna get the preferential tax rate, I should probably do my homework on REITs before going into preferreds.

About the PILs at IB, what I understand is that if IB loaned out some of my shares to somebody (e.g. because they're shorting the stock), then I may get PIL. Since none of the assets I transferred to IB pay dividends, I guess the question is: are there people who short preferreds? That wouldn't make much sense to me, you'd usually be better off shorting the underlying common stock instead.Yes, people often short preferreds just like they often short anything - when they think the price is too high. This might be for a few hours or a few days, and might or might not include the dividend date. You will probably get the dividends rather than PIL at IB even in a margin account, but there are no guarantees. I lost a very large amount due to a PIL situation last year (not a preferred).

My thinking with stop orders was that if I buy preferreds below par that appreciate a bit after a few months, I could put in a stop order to sell them at approximately the face value I bought them for, to get out automatically in case there is a sudden increase in interest rates. But I don't have to do this, it's just something I've been considering.Stop orders aren't a magic solution to avoid losing money. In fact, because of the way they are handled and executed, there's a nontrivial chance they will execute at a time you don't want them to and you end up losing money compared to if you'd done nothing. I wouldn't recommend them, and IB might well keep canceling them every time a dividend rolls around anyway so keeping them in place could be a PITA. In the simplest case, remember that stocks can open down when there's overnight news and no stop order will get you yesterday's price when bad news comes out. For example, see the chart of how a pretty popular insurance stock and their many preferreds fared when they announced they had serious accounting issues.

mr88

New Member

posted: Mar. 23, 2017 @ 3:44a

xerty said: I have been watching and studying preferrred stocks for several years now. I am starting to really understand how they work, how to value them, how to trade them, etc - not an expert on most, but good enough sometimes. I admit I still haven't studied most issues in enough detail to really understand their whole situation and risk profile. I would humbly suggest that your understanding after two weeks is probably still pretty superficial.

I certainly did not mean to claim I had a deep understanding of preferreds, merely that I feel a bit more comfortable with them after having done a bit of homework. One of the big questions I had for you guys also was: what else, along these lines, should I be researching?xerty said: I lost a very large amount due to a PIL situation last year (not a preferred).

Do you want to share a bit more about what happened there? Are you participating in IB's Stock Yield Enhancement Program?xerty said: For example, see the chart of how a pretty popular insurance stock and their many preferreds fared when they announced they had serious accounting issues.

A quick look at AFSI raised a bunch of red flags already: no credit ratings, irregular dividend payments over the past 5 years (if we are to believe Google Finance, which is weird because the common stock seems to have received regular dividends), they've IPO'ed a new issue of preferreds every 6 months on average since mid 2013 (almost 40 million shares at $25 par, representing almost 10% of the market cap of their common stock before they tanked recently), free cash flow was in the red twice over the past 2 years... dunno, armchair commentator here, with the benefit of hindsight, but I wouldn't have bought AFSI.

xerty

Senior Member - 4K

posted: Mar. 24, 2017 @ 9:00p

mr88 said: I certainly did not mean to claim I had a deep understanding of preferreds, merely that I feel a bit more comfortable with them after having done a bit of homework. One of the big questions I had for you guys also was: what else, along these lines, should I be researching?There are some good writers on Seeking Alpha that cover preferreds - that's one place to start. Ideally you want to understand the business risks, cashflows, management incentives, protective covenants (or lack), capital structure and any capital transactions, sector trends from a risk perspective, relative value among any similar instruments of that or similar issuers, etc. This is why I say there are only a few issues I really understand - takes more than a week or two.xerty said: I lost a very large amount due to a PIL situation last year (not a preferred).Do you want to share a bit more about what happened there? Are you participating in IB's Stock Yield Enhancement Program?No and yes, respectively. I am I the SYE program but that wasn't relevant and I wasn't paid for this being borrowed. If your account is on margin by more than a little, they can loan anything and keep the lending revenue since it's "their money" funding them. This is in the margin agreement and is standard. I would have had to move the security to a cash account to avoid this risk, which would have been difficult since it was a large position bought on margin.

ru55ian

New Member

posted: Mar. 28, 2017 @ 12:47p

Hi everyone,

I was searching the web for this exact topic and I am happy that I've found this thread. Anyways, some of my thoughts:

"Dividend paying stocks are much riskier than the typical preferred stock or bond. They drop by the amount of the dividend they pay, so it's not really "free money" to help pay your loan. The risks are more stock market risks"Dividend-paying stocks are indeed riskier than preferred/bond. But it's simply not true that they are riskier than the stock market (assuming SP500). There are high-quality companies, which are focused on stable value-creation - with 0.3 beta, 15% CAGR and 10% dividend yield. The real opportunities are in less liquid markets, so they also tend to be smaller in market-cap and less known.They can drop by the amount of div on ex-div date - or they don't drop. Over a decent time-frame, it doesn't really matter.

In regards to the topic - I would look at smaller, higher-quality/low beta names, rather than the big-banks which were named by the mr88. Of course, this requires more fundamental work and analysis, but looking at this type of companies has certain benefits IMO:1) Lower beta2) Higher yield3) Lower volatility (but also lower liquidity)4) Smaller premiums to par

In addition - I would suggest to look at Senior Notes (baby bonds) vs preferreds', as they tend to experience even less volatility with similar yields. However, they are less liquid and much more limited in supply. But then again, the opportunities tend to present themselves in less liquid names much more often. I've personally found >7% div yield with annualized vol similar to bond funds.

Finally, you could run some regressions on Common/Preferred/Senior during 'stressful times' - to roughly approximate how Preferred Stock/Senior Notes would respond to a significant decline in the Common Shares. I have done it a couple times and the results were quite significant, with very 'precise relationships'.

P.S.Also, in regards to the 'edge' in less known/smaller names. There are companies of the highest quality, less liquid preferreds'/senior notes - and NR rating. Given that these ETD instruments are largely made for retail, I bet that for a lot of people a BBB vs NR is a bigger deal - than the yield. They don't even do their fundamentals homework.

P.P.S.Look at REITs...

ThomasPaine

Titles are but nicknames...

posted: Mar. 28, 2017 @ 6:56p

ru55ian said: Hi everyone,

I was searching the web for this exact topic and I am happy that I've found this thread. Anyways, some of my thoughts:

"Dividend paying stocks are much riskier than the typical preferred stock or bond. They drop by the amount of the dividend they pay, so it's not really "free money" to help pay your loan. The risks are more stock market risks"Dividend-paying stocks are indeed riskier than preferred/bond. But it's simply not true that they are riskier than the stock market (assuming SP500). There are high-quality companies, which are focused on stable value-creation - with 0.3 beta, 15% CAGR and 10% dividend yield. The real opportunities are in less liquid markets, so they also tend to be smaller in market-cap and less known.They can drop by the amount of div on ex-div date - or they don't drop. Over a decent time-frame, it doesn't really matter.

In regards to the topic - I would look at smaller, higher-quality/low beta names, rather than the big-banks which were named by the mr88. Of course, this requires more fundamental work and analysis, but looking at this type of companies has certain benefits IMO:1) Lower beta2) Higher yield3) Lower volatility (but also lower liquidity)4) Smaller premiums to par

In addition - I would suggest to look at Senior Notes (baby bonds) vs preferreds', as they tend to experience even less volatility with similar yields. However, they are less liquid and much more limited in supply. But then again, the opportunities tend to present themselves in less liquid names much more often. I've personally found >7% div yield with annualized vol similar to bond funds.

Finally, you could run some regressions on Common/Preferred/Senior during 'stressful times' - to roughly approximate how Preferred Stock/Senior Notes would respond to a significant decline in the Common Shares. I have done it a couple times and the results were quite significant, with very 'precise relationships'.

P.S.Also, in regards to the 'edge' in less known/smaller names. There are companies of the highest quality, less liquid preferreds'/senior notes - and NR rating. Given that these ETD instruments are largely made for retail, I bet that for a lot of people a BBB vs NR is a bigger deal - than the yield. They don't even do their fundamentals homework.

P.P.S.Look at REITs...First, congrats on such a thorough first post... It's very rare to have an ontopic, informed first poster that isn't touting some product or another. While I agree with your hierarchy of risk, the main concern is their correlation to each other.

The conversation started with the OP buying a condo w/ 30% down payment borrowed from margin, and trying to make side-bets to make up the cash flow. There are two arbitrages he can make, credit quality and interest rate risk. One of the founding values of this forum was borrowing cheap, and lending expensive money, and in those days, that was 6% CDs. The old-timers learned quickly that this was only for the disciplined, and only for ultra-safe deposits/investments

There are some Nobel prize winners who thought they were smart enough to figure out how to solve this, and the results were summarized in the book When Genius Failed. Only fools speculate in rates, but it's hard for me to put aside that people are jumping into riskier asset classes due to the side effects of ZIRP/NIRP, and when we do revert to the mean where bonds are used for fixed income, a lot of money will flow out of these "too smart by half" asset classes.

My whole family has been focused on preferred trading for quite a while now - since about 2010, with about half our assets in preferred stocks. I tend to put them mostly in tax free or deferred accounts.

Do a screen on these - you'll note some distinct patterns. People always mention the "wipe out" but as somebody above mentioned, that just is very unlikely to happen, even with another 2009 type event. Left alone, even if they somehow experience that sort of loss, they will eventually drift back up to their call range (or quickly). Of course if there's a nuclear war or something, all bets are off. Look for a)over 6% b)cumulative c)close to or under call value if they are callable. Most (not all) are issued at $25.

You're not going to get 10% without significant risk, even in REIT's. All those Barclay's, Royal Bank of Scotland, INZ - these are great preferreds, and most of them trade in the 6-8% range which is what I consider "normal" for good preferreds. You'll hit some good REIT's in the 8-9%. Everything over that is wacky, in my opinion. Stay away from the energy companies, the shipping companies, etc - these are the kind that actually could go under.

ru55ian

New Member

posted: Mar. 28, 2017 @ 9:31p

ThomasPaine said: First, congrats on such a thorough first post... It's very rare to have an ontopic, informed first poster that isn't touting some product or another. While I agree with your hierarchy of risk, the main concern is their correlation to each other.

The conversation started with the OP buying a condo w/ 30% down payment borrowed from margin, and trying to make side-bets to make up the cash flow. There are two arbitrages he can make, credit quality and interest rate risk. One of the founding values of this forum was borrowing cheap, and lending expensive money, and in those days, that was 6% CDs. The old-timers learned quickly that this was only for the disciplined, and only for ultra-safe deposits/investments

There are some Nobel prize winners who thought they were smart enough to figure out how to solve this, and the results were summarized in the book When Genius Failed. Only fools speculate in rates, but it's hard for me to put aside that people are jumping into riskier asset classes due to the side effects of ZIRP/NIRP, and when we do revert to the mean where bonds are used for fixed income, a lot of money will flow out of these "too smart by half" asset classes.

It's true that 'risk' is a quite ambiguous term. After years, I'm perceiving risk as a possibility of permanent loss. Everything else is volatility.

In terms of the original topic - I do not consider a leveraged or un-leveraged position in Exchange Traded Debt with 7.5%+ yield to be a speculation on rates - for the next 3 years at least. Especially, if you diversify the capital gains, thus, gaining some margin of safety. I choose low beta, small companies with excellent track record. I believe that leveraged low beta, high sharpe, small and transparent companies at cheap prices > everything else. Obviously, 'beta'/'sharpe'/'volatility' are just labels - a consequence, which is represented in price action. The causes, the underlying operations - are key.

Lastly, I've recently discussed a somewhat similar topic with some people...And I find it rather funny, how "...going 3X-lever on an excellent instrument @ 6.0% annualized vol..." - is perceived to be 'risky'...But having long cash position, @40-50% annualized vol is absolutely fine. Leverage aversion indeed.

Just my two cents, thanks.

ru55ian

New Member

posted: Mar. 28, 2017 @ 9:50p

bluegreenturtle said: My whole family has been focused on preferred trading for quite a while now - since about 2010, with about half our assets in preferred stocks. I tend to put them mostly in tax free or deferred accounts.

Do a screen on these - you'll note some distinct patterns. People always mention the "wipe out" but as somebody above mentioned, that just is very unlikely to happen, even with another 2009 type event. Left alone, even if they somehow experience that sort of loss, they will eventually drift back up to their call range (or quickly). Of course if there's a nuclear war or something, all bets are off. Look for a)over 6% b)cumulative c)close to or under call value if they are callable. Most (not all) are issued at $25.

You're not going to get 10% without significant risk, even in REIT's. All those Barclay's, Royal Bank of Scotland, INZ - these are great preferreds, and most of them trade in the 6-8% range which is what I consider "normal" for good preferreds. You'll hit some good REIT's in the 8-9%. Everything over that is wacky, in my opinion. Stay away from the energy companies, the shipping companies, etc - these are the kind that actually could go under.

Hearing a 'wipe-out' is a bit hilarious. I've recently analyzed one instrument, with both common shares/preferred's/senior notes...In 2008, the preferred's dropped -36% (un-adjusted for dividend) - would be around -26% with div...and this implies, that you've initiated the position right before the drop...In a similar sense, my analysis showed a max div un-adjusted loss of ~ -16-18% for Senior Notes...a wipe out indeed.

But I understand where 'this' is coming from. People focus on generic, liquid, shitty paper - and get scared when they look at PFF/etc in 2008. Well, what do you expect to happen - if you don't want to do extra work?It's like some REIT going 7x on agency paper with a ton of libor swaps - there is no edge in that. Plus, diversification through ETFs is simply inefficient - there are NR senior notes with lower premiums/better yields, than some BBB.

In terms of REITs - there are some excellent candidates, with more than 2x better risk-adjusted returns than equity indices; hybrid-MBS. Risk? They tend to be a little bit volatile sometimes, but if the company is great - it's an opportunity, not a risk. It's just the nature of their business. As one chief operations officer told me, "...We see an opportunity - we buy the paper. As long as our cash flow/credit assumptions don't change - we don't care, what our BV does..."

xerty

Senior Member - 4K

posted: Mar. 28, 2017 @ 10:26p

ru55ian said: It's like some REIT going 7x on agency paper with a ton of libor swaps - there is no edge in that. That's pretty much the mortgage REIT (mREIT) business model, right? Punting on interest rates, pay a high apparent dividend, and hope for the best?

xerty said: ru55ian said: It's like some REIT going 7x on agency paper with a ton of libor swaps - there is no edge in that. That's pretty much the mortgage REIT (mREIT) business model, right? Punting on interest rates, pay a high apparent dividend, and hope for the best? Yes, that's the business model of a good amount of mREITs. But I wouldn't apply it to each and every company. There is an extremely limited amount of so-called "hybrid-mREITs"; low-leverage players, which have >60% of their assets in 3y step-up securities, NPL/RPL and Residential Whole Loans. Extremely low duration - specialization on performing credit work and ability to invest in less liquid paper (thanks to smaller mcap and lever). Basically, higher credit spread with lower lever - instead of what the majority does - low credit spread with higher lever. And the majority loses on their huge duration hedges, regardless of whether rates move down or up. I've attached a small chart I've done a while ago on one of these mREITs (in red) - compared them to some big players, AGNC and NLY, I believe. And I totally understand your point, if you look at these two.

In terms of ETDs...if you look at some 'big names' - like EBAYL, GSJ, VZA...Yields from 5.9% to 6.5%, volatile, and average current premium ~ 4.0%. Doesn't look too good.

calwatch

Senior Member - 1K

posted: Mar. 29, 2017 @ 10:41p

With regard to the payments in lieu of dividends thing, I've been levered at IB at a 2:1 ratio for sometime (mostly on ETFs, such as VNQ and LQD, i.e. I'm invested in triple my liquidation value) and last year's 1099 was at a 3:1 ratio of PILO to actual dividends. Of course, LQD and VNQ pay out ordinary dividends so it is irrelevant whether they are payments in lieu of not, since they can be offset as investment expenses on Schedule A regardless.

TravelerMSY

Senior Member - 8K

posted: Mar. 29, 2017 @ 10:46p

Is the issue here that if you hold an asset (that ordinarily pay qualified dividends) on margin, that you may get payment in-lieu instead taxed as regular income?

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